Governor needs to rethink his solution

The defeat of Measure 28 is not Oregon's greatest fiscal problem. PERS is.

Unfortunately, Gov. Ted Kulongoski's key proposal to fix the Public Employees Retirement System is wrong. The governor is very, very right that a major fix is needed, and he shows courage in not trying Band-Aid solutions. He's also right to keep the Legislature focused on fixing PERS, a necessary step toward putting future state and local government and school budgets on firmer ground.

However, the governor's proposal to replace PERS with a defined-benefit pension plan will set Oregon up for future crises, albeit not of the magnitude we are now experiencing.

The greatest problem with PERS is the dual option that all members have. At retirement, they get the better of two formulas. The first is a defined-benefit formula based on years of service and final salary. (This is called 'full formula' in PERS lingo.) Benefits also are calculated under a defined-contribution method, in which investment returns are compounded over time ('money match' in the language of PERS).

When investment returns are high, PERS must match the high returns in employees' accounts. But when investment returns are low, PERS has to pay the guaranteed benefit under full formula. This, more than any other problem, has caused the crisis in PERS. Kulongoski recognizes that this double option has to end, and he is to be commended for saying so.

The governor's proposal, however, exposes the state to substantial risk in the years ahead. His approach, to replace PERS with a pure defined-benefit plan, is being abandoned by corporations and should be shunned even more by state governments.

In well-administered plans, years of high investment returns make up for years of poor investment returns. In the time of Joseph, the seven fat years were followed by seven lean years. The pattern continues to this day, though not necessarily in seven-year stretches.

What would the state Legislature do with a defined-benefit plan after seven fat years of investment performance, such as we had from 1992 through 1999? Someone from the public employee unions would suggest raising benefits. After the fat years, the money already would be in the trust fund. We can improve benefits, and it won't cost a thing. As sure as lobbyists look out for their clients, as sure as politicians look for votes, the Legislature would vote to spend the surplus in the new retirement trust fund.

Then the lean years would come. There would be no excess to draw upon. Taxpayers would have to cough up more money or accept cuts in government services to pay the generous benefits. The crisis would emerge anew.

Defined-benefit plans also produce serious inequities. The formulas favor long-term employees over shorter-tenured workers. This is exactly backward from what an employee incentive system should do. The employee with 25 years of service is unlikely to be looking around for another job. The two-year employee, however, is going to look at other possibilities. In short, the defined-benefit plan does little for those who need encouragement to stay in government service and does a lot for people who would not consider changing jobs anyway.

Oregon needs to replace PERS with a straight defined-contribution plan, along the lines of a 401(k). Every employee would be vested from Day One.

Political risk? The only way to provide more benefits in a defined-contribution plan is to put more money in. Legislators could do that in the future, but they wouldn't be misled by a few years of strong investment returns into thinking that extra benefits are free.

The governor's defined-benefit plan would subject the state to substantial political risk, which would cause repeats of today's fiscal crisis.

William B. Conerly is chairman of the board of the Cascade Policy Institute and the principal of Conerly Consulting. He is a member of Gov. Ted Kulongoski's Council of Economic Advisors and served on the work group of the House Special Task Force on PERS Sustainability and Accountability. He holds a Ph.D. in economics from Duke University.Ê